TECHNOLOGY IN BANKING:

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CHAPTER 3

• TECHNOLOGY IN BANKING
• E-MONEY, E-BANKING,
• AND E-COMMERCE

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LEARNING OBJECTIVES

• To understand
• Bank technology in term of e-money, e-banking,
  and e-commerce
• How e-commerce affects the set-of-contracts
  theory of the firm and the similarities between
  banks and communications firms
• E-banking as the delivery system based on
  electronic funds transfer (EFT)

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LEARNING OBJECTIVES (continued)

• To understand
• The components of EFT as ACHs, ATMs, and POSs
• Home banking was a bust in the late 20th century
  but that Internet banking and e-commerce will
  take off in the early 21st century

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CHAPTER THEME

• This chapter focuses on the information-processing
  and e-delivery aspects of banking from a
  technological perspective.
• Innovations related to information technology
  (the I in TRICK) have paved the way for e-money,
  e-banking, and e-commerce.
• EFTS and Internet banking are the delivery
  vehicles of the 21st century.

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ARE BANKS DINOSARUS?

• Yes
• No
• Maybe

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Banks Are Dinosaurs

• Technology in the Workplace Study Criteria
• Has the industry made use of technological
  advances in a timely manner?
• Did it participate in or encourage the
  development of new technologies?
• Has the industry improved its competitive
  standing, efficiency, or profitability?
• Bankings Grade C-

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BANKS ARE NOT DINOSAURS

• Technological Innovations
• E-Money
• E-Banking
• E-Commerce
• Electronic Funds Transfer Systems

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E-COMMERCE AND THE SET OF CONTRACTS THEORY OF THE
FIRM

• Figure 3-1 (p. 67)

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THE SET OF CONTRACTS THEORY OF THE FIRM

• Theory from Jensen and Meckling (1976)
• Basic idea is to think about the various groups
  that have claims on the firms assets/cash flow
• Narrow view suggests only two claimants Owners
  and creditors

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SET-OF-CONTRACTS THEORY(continued)

• Broader view has many claimants including
  employees, tax collectors, society, suppliers,
  customers, and regulators.
• Advances in technology permit information flows
  between and among these parties/claimants to be
  more timely and efficient

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THREE IMPORTANT WEB CONCEPTS

• Business-to-Customers (B2C)
• Business-to-Business (B2B)
• Business-to-Employees (B2E)
• To which we can add,
• Banks-to-Regulators (B2R)

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INFORMATION TECHNOLOGY AND TRICK

• Transparency -- permits debt and equity holders
  to receive information on a more timely basis
• Risk Exposure - eases managers ability to sell
  and buy risk management
• Customers -- enhances banks abilities to
  communicate, inform, and attract
• Kapital Adequacy -- reduces agency costs
  associated with bank and securities regulations

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E-commerce uses IT to enhance communications and
transactions among mangers and stakeholders

• Claimant Example
• Shareholders E-voting
• Creditors E-reports
• Supplier/distributor E-orders
• Customers E-orders
• Employees E-mail
• Regulators/IRS E-filings
• Society E-info

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THE EVOLUTION OF MONEY

• CONCRETE
• (animals, hides, trinkets, gold)
• to
• ETHEREAL
• (electronic impulses)

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CHECKS

• Check Volume
• Check Imaging
• Electronic-Check Presentment
• Electronic-Check Conversion

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CARDS

• TYPES
• Credit Cards
• Debit Cards
• Smart Cards or Chip Cards
• WAYS TO BE USED
• Face-to-Face or card present
• Mail order / telephone order (MOTO)
• Internet

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E-BANKING PAYMENTS SYSTEMS

• Automated Clearinghouses (ACHs, see Figure 3-2,
  p. 73)
• Automated Teller Machines (ATMs, see Figure 3-4,
  p. 80)
• Point-of-Sale Terminals
• Internet Banking

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PAY CARDS AND THE UNDERBANKED

• A pay card
• looks like a credit card,
• acts like a debit card, and
• permits customers to receive electronic payments,
• but it is not tied to a conventional bank
  account
• Pay cards are marketed through
• employers that offer direct deposit and to
• parents for teens

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WIRE-TRANSFER SYSTEMS

• CHARACTERISTICS
• High-dollar value of average transfers
• Real-time settlement
• A widely distributed network of users
• SYSTEMS
• Fedwire (see Figure 3-3, p. 77)
• CHIPS (Clearing House Interbank Payment System)
• SWIFT (Society of World Interbank Financial
  Telecommunications)

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FEDWIRE

• Funds Transfer Service
• Real-time gross settlement system
• Custodial and Transfer Services
• 1. Safekeeping Function
• 2. Transfer-and-Settlement Function

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CHIPS and SWIFT

• CHIPS
• Clearing House Interbank Payment System
• 95 of money moving internationally
• SWIFT
• Society of World Interbank Financial
• Telecommunications
• Primarily Messaging

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MONEY LAUNDERERS AND TERRORIST FINANCING

• Box 3-3 (p. 79) describes how money launderers
  use wire transfers
• Aggregate funds in bank account of legitimate
• Following 11 September 2001 great attention has
  been drawn to how terrorists use financial
  systems and underground (cash) transactions to
  circumvent detection
• When a paper trail exists, authorities freeze
  assets to impede funding

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E-BANKING ATMs

• ATM or
• Pay 3 to deal with a Teller
• The Numbers Game
• 1980 lt 20,000 ATMs
• 2000 gt200,000 ATMs
• During the 1990s, ATMs grew at a rate of 10 per
  year
• ATM Networks
• HONOR, PLUS, MAC, STAR, NYCE, MOST, CIRRUS

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POINT OF SALE SYSTEMS

• 53,000 in the early 1990s versus 2,000,000 in
  2000
• Why were they so slow to grow?
• Payment habits are slow to change and customers
  prefer credit cards with a grace period or
  checks with float to debit cards
• Merchants have gone with technologies more
  focused on electronic cash registers and
  inventory control rather that EFT

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INTERNET BANKING

• --Andy Grove, CEO of Intel
• (1996)
• The Internet is like a 20-foot tidal wave coming,
  and we are in kayaks.
• Its been coming across the Pacific for thousands
  of miles and gaining momentum, and its going to
  lift you and drop you.
• Were just a step away from the point when every
  computer is connected to every other computer, at
  least, in the U.S., Japan, and Europe.
• It affects everybody -- the computer industry,
  telecommunications, the media, chipmakers, and
  the software world.
• Some are more aware of this than others.

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ELECTRONIC DATA INTERCHANGE (EDI)

• EDI refers to the process of exchanging
  information electronically (e.g., invoices,
  purchase orders, and remittances)
• Why?
• Speed the flow of dollars and data
• Omnibus Consolidated Rescission and
  Appropriations Act of 1996 (requires federal
  agencies to convert to EFT)

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OUTSOURCING

• Do We Perform Computer Operations In House or
  Contract with a Third Party?
• Outsourcing varies inversely with bank size as
  only 21 of banks with assets over 10 billion
  prefer to outsource compared to 40 for banks
  with total assets under 500 million

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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

• Factors Contributing to the Decline of Community
  Banks
• Failure to address the financial needs of baby
  boomers
• Burdensome regulations that create an unlevel
  playing field favoring nonbank competitors
• Inability to afford the high cost technology
  necessary to compete
• Financial innovations such as securitization and
  the development of secondary markets that are
  transforming banking into a pure commodity
  business

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PRODUCT AND SERVICE TRENDS IN BANKING

• Internet banking and bill-paying services
• Cash-management services
• Debit and chip (smart) cards
• Upgraded branch-delivery and loan systems
• Imaging technology
• More efficient data storage (and greater concern
  about security (backup systems) in the aftermath
  of 11 September 2001)

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TECHNOLOGY AND THE FUTURE OF COMMUNITY BANKS

• How can Community Banks Compete?
• Invest in Niches
• Leverage Their Core-Systems Vendors
• Make Small Size an Advantage
• Utilize Application Service Providers
• Build Internal Integration Skills
• Dont be Penny Wise but Pound Foolish

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FINANCIAL-MANAGEMENT IMPLICATIONS OF E-BANKING

• View in terms of the ROE model
• ROE PM x AU x EM ROA x EM
• Greater efficiency gt higher PM and higher ROA
  and ROE, ceteris paribus (other things being
  equal)
• Revenue (sales) enhancement (e.g., through
  cross-selling) gt higher AU and higher ROA and
  ROE, ceteris paribus
• Affect EM through more efficient use of equity
  capital gt higher ROE

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BANKS AS COMMUNICATIONS FIRMS

• They are similar in that they both
• Establish networking relationships through which
  they
• Collect, store, process and transmit information
  for themselves and the customers accounts
• Not a two-way street
• It is easier for communications firms to enter
  financial-services businesses than the other way
  around

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CHAPTER SUMMARY

• Bill Gates predicts that online banking (virtual
  branches) will become the primary vehicle for
  delivering financial products and services
• E-money, e-banking, and e-commerce provide the
  platforms for Gates prediction to come true